Internal Revenue Bulletin:
2006-47

November 20, 2006

Rev. Rul. 2006-57

Qualified transportation fringes; smartcards and
debit cards. This ruling provides guidance to employers on the
use of smartcards and debit cards to provide qualified transportation fringes
under section 132(f) of the Code.

ISSUE

Whether, under the facts described, employer-provided transportation
benefits provided through smartcards, debit or credit cards, or other electronic
media are excluded from gross income under §§ 132(a)(5) and
132(f) of the Internal Revenue Code and from wages for employment tax purposes.

FACTS

Situation 1. For 2006, Employer A provides to
its employees transportation benefits in an amount not exceeding $105 each
month. Transit system X provides smartcards that may be used by employers
in the metropolitan area served by X as a mechanism to provide fare media
for transit system X to employees. The smartcards are plastic cards containing
a memory chip that stores certain information including the serial number
of the card and the value of the fare media stored on the card. The amount
stored as fare media on the smartcard is not authorized to be used to purchase
anything other than fare media for X. A uses the smartcards as a mechanism
to provide transportation benefits to its employees. A makes monthly payments
to X on behalf of its employees who participate in the transportation benefit
program, which X then electronically allocates to each employee’s smartcard
as instructed by A. A does not require its employees to substantiate their
use of the smartcards.

Situation 2. For 2006, Employer B provides to
its employees transportation benefits in an amount not exceeding $105 each
month. Debit card provider P provides debit cards that may be used by employers
to provide transportation benefits to their employees. The debit cards are
restricted for use only at merchant terminals at points of sale at which only
fare media for transit system Y is sold. B uses the terminal-restricted debit
cards provided by P as a mechanism to provide transportation benefits to its
employees. B makes monthly payments to P on behalf of its employees who participate
in the transportation benefit program, which P then electronically allocates
to each employee’s terminal-restricted debit card as instructed by B.
B does not require its employees to substantiate their use of the debit cards.

Situation 3. For 2006, Employer C provides to
its employees transportation benefits in an amount not exceeding $105 each
month. Debit card provider Q provides debit cards that may be used by employers
as a mechanism to provide transportation benefits to their employees. Q restricts
the use of the debit cards to merchants that have been assigned a merchant
category code (MCC) indicating that the merchant sells fare media. The cards
are restricted for use at merchants that have been assigned MCCs indicating
the merchant sells fare media for some or all of the following categories:
local and suburban commuter passenger transport; passenger railway; bus lines,
excluding charters and tours; and transportation service (not elsewhere classified).
The merchant may or may not sell other merchandise. The MCCs were developed
by S, which is a debit/credit card network. S determines and updates the
MCC assigned to a particular merchant based on information provided by the
merchant. C uses the MCC-restricted debit cards provided by Q as a mechanism
to provide transportation benefits to its employees. A voucher or similar
item exchangeable only for a transit pass is not otherwise readily available
for purchase by C for direct distribution to C’s employees within the
meaning of § 132(f)(3).

For the first month an employee participates in the transportation benefit
program, the employee pays for fare media with after-tax amounts. The employee
then substantiates to C the amount of fare media expenses incurred during
the month following reasonable substantiation procedures implemented by C
as described in § 1.132-9(b) Q/A-16(c). C then remits to Q an amount
equal to the amount of substantiated fare media expenses for the prior month,
which Q then electronically allocates to the debit card assigned to the employee.
For subsequent months, C reimburses the employee for fare media expenses
incurred by the employee by providing funds to Q to be allocated to the employee’s
debit card equal to the amount of fare media expenses substantiated under
the following procedures (not exceeding the monthly limit provided under § 132(f)(2)).
With respect to expenses for which employees seek reimbursement that were
paid using the MCC-restricted debit card, C receives periodic statements providing
information on the use of each debit card, which include information on the
identity of the merchants at which the debit card was used, and the date and
amount of the debit card transactions. In addition, for the first month the
debit card was used, prior to providing reimbursement, C requires that the
employee certify that the debit card was used only to purchase fare media.
For subsequent months, C does not require employee certifications prior to
reimbursement of recurring expenses that match expenses previously substantiated
under the procedures described above as to seller and time period (e.g.,
for an employee who purchases a transit pass on a regular basis from the same
seller). However, C requires a recertification at least annually from each
employee that the debit card was used only to purchase fare media. C reviews
the periodic statements in combination with the employee certifications to
determine the transit pass expenses incurred by each employee through the
use of the debit card and reimburses each employee for the expenses that have
been substantiated by transmitting funds to Q to be allocated electronically
to each employee’s debit card. With respect to fare media expenses
for which C’s employees seek reimbursement that were not paid using
the MCC-restricted debit card, the employees substantiate the amount of the
fare media expenses incurred following reasonable substantiation procedures
implemented by C as described in § 1.132-9(b) Q/A-16(c). For example,
an employee receiving reimbursements of less than the maximum monthly excludable
amount of transportation expenses may increase his or her reimbursements for
future months by paying for increased fare media expenses by some method other
than the use of the debit card and substantiating the additional amount using
reasonable substantiation procedures as described in § 1.132-(9)(b)
Q/A-16(c).

Situation 4. The facts are the same as in Situation
3, except in the following respects. Employer C provides employees with
MCC-restricted debit cards as soon as they begin work. Prior to using the
MCC-restricted debit cards, C’s employees certify that the card will
be used only to purchase transit passes. In addition, written on each debit
card is the statement that the card is to be used only for transit passes,
and, by using the card, the employee certifies that the card is being used
only to purchase transit passes. At no time do C’s employees substantiate
to C the amount of fare media expenses that have been incurred.

LAW

Section 61(a)(1) of the Code provides that, except as otherwise provided
in subtitle A, gross income includes compensation for services, including
fees, commissions, fringe benefits, and similar items.

Section 132(a)(5) provides that any fringe benefit that is a qualified
transportation fringe is excluded from gross income. Section 132(f)(1) provides
that the term “qualified transportation fringe” means (1) transportation
in a commuter highway vehicle between home and work, (2) any transit pass,
and (3) qualified parking. The amount of the fringe benefit which may be
excluded from gross income and wages for 2006 is limited to $105 per month
for the aggregate of transportation in a commuter highway vehicle and transit
passes, and $205 per month for qualified parking. See § 132(f)(2);
Rev. Proc. 2005-70, 2005-47 I.R.B. 979, § 3.12.

Section 132(f)(5)(A) provides that a transit pass is any pass, token,
farecard, voucher or similar item entitling a person to transportation (or
transportation at a reduced price) if such transportation is on mass transit
facilities or is provided by any person in the business of transporting persons
for compensation or hire in a commuter highway vehicle. See § 132(f)(5)(B)
for the definition of a commuter highway vehicle.

Section 132(f)(3) provides that a qualified transportation fringe includes
a cash reimbursement by an employer to an employee for transit benefits.
However, a qualified transportation fringe includes a cash reimbursement by
an employer to an employee for a transit pass only if a voucher or similar
item that may be exchanged only for a transit pass is not readily available
for direct distribution by the employer to the employee.

Section 1.132-9(b) Q/A-16(b)(1) of the Income Tax Regulations provides
that if a voucher or similar item is readily available, the requirement that
a voucher or similar item be distributed in-kind by the employer is satisfied
if the voucher is distributed by the employer or by another person on behalf
of the employer (for example, if a transit operator credits amounts to the
employee’s fare card as a result of payments made to the operator by
the employer).

Section 1.132-9(b) Q/A-16(b)(2) provides that a transit system voucher
is an instrument that may be purchased by employers from a voucher provider
that is accepted by one or more mass transit operators in an area as fare
media or in exchange for fare media. Under § 1.132-9(b) Q/A-16(b)(3),
a voucher provider is any person in the trade or business of selling transit
system vouchers to employers, or any transit system or transit system operator
that sells vouchers to employers for the purpose of direct distribution to
employees.

Section 1.132-9(b) Q/A-16(b)(4) provides that a voucher or similar item
is readily available for direct distribution by an employer to employees if
and only if the employer can obtain it from a voucher provider that does not
impose fare media charges greater than 1 percent of the average annual value
of the voucher for a transit system, and does not impose other restrictions
causing the voucher not to be considered readily available. See § 1.132-9(b)
Q/A-16(b)(5) and (b)(6).

Section 1.132-9(b) Q/A-16(a) provides that the term qualified transportation
fringe includes cash reimbursement for transportation in a commuter highway
vehicle, transit passes (if permitted), and qualified parking, provided the
reimbursement is made under a bona fide reimbursement
arrangement. A payment made before the date an expense has been incurred
or paid is not a reimbursement. In addition, a bona fide reimbursement
arrangement does not include an arrangement that is dependent solely on the
employee certifying in advance that the employee will incur expenses at some
future date. Under § 1.132-9(b) Q/A-16(c), whether a reimbursement
is made under a bona fide reimbursement arrangement depends
upon the facts and circumstances. The employer must implement reasonable
procedures to ensure that the amount equal to the reimbursement was incurred
for transportation in a commuter highway vehicle, transit passes, or qualified
parking. Section 1.132-9(b) Q/A-16(d) provides that reasonable reimbursement
procedures include the collection of receipts from employees or obtaining
employee certifications in appropriate circumstances. The regulations provide
that obtaining an employee’s certification is a reasonable reimbursement
procedure if receipts are not provided by the seller in the ordinary course
of business, and if the employer has no reason to doubt the employee’s
certification.

Section 1.132-9(b) Q/A-18 provides that there are no employee substantiation
requirements if an employer distributes a transit pass (including a voucher
or similar item) in-kind to the employer’s employees.

Section 3121(a)(20) excepts from the definition of “wages”
for FICA tax purposes any benefit provided to or on behalf of an employee
if, at the time such benefit is provided, it is reasonable to believe that
the employee will be able to exclude such benefit from gross income under
§ 132. Sections 3306(b)(16) and 3401(a)(19) provide similar exclusions
for FUTA and Federal income tax withholding purposes respectively.

ANALYSIS

In Situation 1, the fare media value stored on the smartcards is useable
only as fare media for transit system X. Thus, the smartcard qualifies as
a transit system voucher under § 1.132-9(b) Q/A-16(b)(2) distributed
in-kind by A to its employees. In addition, the amount allocated to each
employee’s smartcard is within the amount specified by § 132(f)(2)(A).
Accordingly, the value of the fare media provided by A to its employees through
the use of the smartcards is excluded from the employees’ gross income
as a qualified transportation fringe benefit within the meaning of § 132(a)(5)
without requiring the employees to substantiate their use of the smartcards.

In Situation 2, the terminal-restricted debit card provided by B to
its employees qualifies as a transit system voucher under § 1.132-9(b)
Q/A-16(b)(2) because it can be used only at merchant terminals at points of
sale at which only fare media for transit system Y can be purchased. In addition,
the amount allocated to each employee’s debit card each month is within
the amount specified by § 132(f)(2)(A). Therefore, the value of
the fare media provided by B to its employees through the use of the terminal-restricted
debit cards is excluded from its employees’ gross income as a qualified
transportation fringe benefit within the meaning of § 132(a)(5)
without requiring the employees to substantiate their use of the debit cards.

In Situation 3, the debit card provided by C to its employees does not
qualify as a transit system voucher under § 1.132-9(b) Q/A-16(b)(2)
because it is possible that a MCC-restricted debit card may be used to purchase
items other than transit passes. A merchant properly classified to accept
the debit card as payment may sell merchandise other than transit passes,
and there is nothing in the debit card technology which prevents its use to
purchase things other than transit passes.

Because a voucher or similar item exchangeable only for fare media is
not readily available to C for direct distribution to its employees, § 132(f)(3)
permits C to provide qualified transportation benefits in the form of cash
reimbursements for transit pass expenses, but only if the reimbursements are
provided under a bona fide reimbursement arrangement.
With respect to expenses incurred during the first month an employee participates
in the transportation benefit program, and with respect to expenses not paid
using the MCC-restricted debit card, C has implemented reasonable substantiation
procedures as described in § 1.132-9 Q/A-16(c). With respect to
expenses paid using the MCC-restricted debit card, C receives periodic statements
providing information on the purchases made with the debit card, including
the identity of the seller, and the date and amount of the debit card transactions.
In addition, for the first month an employee uses the MCC-restricted debit
card, C requires that the employee certify that the card was used only to
purchase fare media. C does not require monthly certifications with respect
to recurring items if the item described in the periodic statement matches
with respect to seller and time period items that have previously been substantiated
as transit pass expenses. However, C requires at least an annual recertification
from each employee that the debit card was used only to purchase fare media.
Prior to remitting an amount to Q as reimbursement for transit pass expenses
for an employee, C examines the periodic statements describing debit card
transactions in combination with employee certifications to determine the
transit pass expenses incurred by each employee through the use of the debit
card. C provides funds to Q to be electronically allocated to the debit cards
only as reimbursements for substantiated transit pass expenses that have been
incurred and substantiated in this fashion. Based on the facts and circumstances,
C has established a bona fide reimbursement arrangement
for transit passes within the meaning of § 1.132-9 Q/A-16(c). In
addition, the amount of the monthly benefit is within the amount specified
by § 132(f)(2)(A). Therefore, the value of the fare media provided
by C to its employees through the use of the MCC-restricted debit cards is
excluded from its employees’ gross income as a qualified transportation
fringe benefit within the meaning of § 132(a)(5).

In Situation 4, as discussed above, the MCC-restricted debit card does
not qualify as a transit system voucher under § 1.132-9(b) Q/A-16(b)(2).
Because a voucher or similar item is not otherwise readily available to C,
C may provide qualified transportation fringe benefits in the form of cash
reimbursements for transit passes under a bona fide reimbursement
arrangement. C provides the debit cards in advance, requiring its employees
to certify that they will use the cards exclusively to purchase transit passes.
This arrangement does not constitute a bona fide reimbursement
arrangement under § 1.132-9(b) Q/A-16(c) because it provides for
advances rather than reimbursements and because it relies solely on employee
certifications provided before the expense is incurred. Those certifications,
standing alone, do not provide the substantiation of expenses incurred necessary
for there to be a bona fide reimbursement arrangement.
Because C is providing restricted-use debit cards that are not transit system
vouchers, and because C is not reimbursing its employees for fare media expenses
under a bona fide reimbursement arrangement, the amounts
C provides to its employees through the use of the MCC-restricted debit cards
are included in its employees’ gross income and wages.

HOLDINGS

Situation 1. The value of the transit pass benefits provided by A to
its employees through the use of the smartcards is excluded from gross income
under § 132(a)(5) and from wages for employment tax purposes.

Situation 2. The value of the transit pass benefits provided by B to
its employees through the use of the terminal-restricted debit card is excluded
from gross income under § 132(a)(5) and from wages for employment
tax purposes.

Situation 3. The value of the transit pass benefits provided by C to
its employees through the use of the MCC-restricted debit card is excluded
from gross income under § 132(a)(5) and from wages for employment
tax purposes.

Situation 4. The amounts provided by C to its employees through the
use of the MCC-restricted debit cards are not excluded from gross income under
§ 132(a)(5) and are wages for employment tax purposes.

EFFECTIVE DATE

This revenue ruling is effective January 1, 2008. Employers and employees
may rely on this revenue ruling with respect to transactions occurring prior
to January 1, 2008. As discussed in Notice 2004-46, 2004-2 C.B. 46, if a
debit card qualifies as a voucher or similar item, then cash reimbursement
for transit pass expenses would be precluded if such a debit card were readily
available. The Treasury Department and the Internal Revenue Service will
continue to review this issue, including the circumstances under which a terminal-restricted
debit card may be considered not readily available because of implementation
charges or other restrictions within the meaning of § 1.132-9(b)
Q/A-16(b)(6) that effectively prevent the employer from obtaining the debit
card for distribution to employees.

As terminal-restricted debit cards appear not to be widely used at present
in areas where cash reimbursement is permissible, the Treasury Department
and the Internal Revenue Service lack sufficient factual context to develop
guidance at this time regarding when terminal-restricted debit cards are readily
available. As use of terminal-restricted debit cards increases in cash-reimbursement
areas, we intend to issue guidance clarifying under what situations the cards
are considered to be readily available and thus preclude cash reimbursement
for transit benefits. Until such guidance is issued, the Service will not
challenge the ability of employers to provide qualified transportation fringes
in the form of cash reimbursement for transit passes when the only available
voucher or similar item is a terminal-restricted debit card.

DRAFTING INFORMATION

The principal authors of this revenue ruling are David R. Ford and John
Richards of the Office of Associate Chief Counsel (Tax Exempt & Government
Entities). For further information regarding this revenue ruling, contact
John Richards at (202) 622-6040 (not a toll-free call).